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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

OR

FOR THE TRANSITION PERIOD FROM              TO             

Commission File Number 000-22873

NUVELO, INC.

(Exact Name of Registrant as Specified in Its Charter)

675 ALMANOR AVENUE, SUNNYVALE, CA 94085

(Address of Principal Executive Offices, including Zip Code)

408-215-4000

(Registrant’s Telephone Number, including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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NUVELO, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2004

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ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NUVELO, INC.

Condensed Consolidated Balance Sheets

(in thousands, except share data)

(unaudited)

See accompanying notes to condensed consolidated financial statements.

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NUVELO, INC.

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

See accompanying notes to condensed consolidated financial statements.

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NUVELO, INC.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

See accompanying notes to condensed consolidated financial statements.

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NUVELO, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2004

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by Nuvelo, Inc., also referred to as Nuvelo, the Company, we, us, or our, in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The accompanying financial information is unaudited, but includes all adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of its financial position, operating results and cash flows for the periods presented. The condensed consolidated balance sheet as of December 31, 2003 is derived from the Company’s audited financial statements. The condensed consolidated financial statements include the accounts of the Company’s majority-owned subsidiary Callida Genomics, Inc., also referred to as Callida Genomics, or Callida. The results of operations for the interim period shown herein are not necessarily indicative of operating results expected for the entire year.

2. Significant Accounting Policies

During interim periods, the Company has followed the accounting policies described in its Annual Report on Form 10-K for the fiscal year ended December 31, 2003. Please refer to such Annual Report when reviewing this Form 10-Q and the following additional significant accounting policy.

Clinical Trial Manufacturing Expense and Clinical Trial Supplies Asset

The Company recognizes clinical trial manufacturing expense when manufacturing is completed and the clinical trial material is shipped from the manufacturing facility to the testing site. Prior to shipment from the clinical trial manufacturing facility, the Company reflects the manufactured clinical trial material and material in process as Clinical Trial Supplies on the accompanying balance sheet in accordance with FASB Statement of Financial Accounting Standards (SFAS) No. 2 Accounting for Research and Development Costs as there are alternative future uses for these supplies in indications not currently being studied. On a quarterly basis, the Company evaluates if there continues to be alternative future use for the clinical trial supplies. Any unconsumed clinical trial supplies will be expensed as research and development in the quarter in which a future alternative use ceases to exist.

3. Stock-Based Compensation

In accordance with the provisions of Statement of Financial Accounting Standards, or SFAS, No. 123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” the Company has elected to account for stock-based compensation to employees under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related interpretations, and to adopt the “disclosure only” alternative described in SFAS No. 123, as amended by SFAS No. 148, had the fair value method been used. The Company’s pro forma information follows (in thousands, except for per share information):

4. Common Stock

On February 23, 2004, the Company implemented a 1-for-3 reverse stock split and reduced the number of outstanding shares of common stock accordingly. On the effective date of February 23, 2004, each holder of record was deemed to hold one share of common stock for every three shares held immediately prior to the effective date. The Company made cash payments for fractional shares to holders who had a number of shares not evenly divisible by three. The reverse stock split was approved by the Company’s shareholders in June 2003 and was implemented to facilitate a public offering of 5,750,000 million shares of common stock completed on March 8, 2004.

Following the effective date of the reverse stock split, the par value of the common stock remained at $0.001. As a result, the Company reduced the common stock in its Consolidated Balance Sheet as of the effective date by approximately $51,000 in 2003, with a corresponding increase in additional paid-in capital. All share and per-share amounts, with the exception of par value, have been retroactively adjusted for all periods presented to reflect the 1-for-3 reverse stock split. The number of common shares authorized for issuance will remain at 100,000,000 shares.

In a public offering completed on March 8, 2004, the Company raised approximately $69.5 million, net of total underwriters’ fees and stock issuance costs of $5.3 million, from its sale of 5,750,000 shares of its common stock, including 750,000 shares related to the exercise of an over-allotment option granted to the underwriters, at a price of $13.00 per share. The Company intends to use the net proceeds for general corporate purposes, including capital expenditures and to meet working capital needs. The Company expects from time to time to evaluate the acquisition of businesses, products and technologies for which a portion of the net proceeds may be used.

5. Bank Facilities

On August 31, 2004, the Company entered into a Loan and Security Agreement, or Loan Agreement, with Silicon Valley Bank that provides it with a $4,000,000 revolving credit line and a $6,000,000 term loan facility and grants Silicon Valley Bank a security interest over certain of its assets, excluding intellectual property. As a condition precedent to the Loan Agreement, the Company agreed, among other things, to certain covenants and reporting requirements. The proceeds of the revolving credit line will be used solely for the Company’s working capital and other general business requirements, and its existing letter of credit issued to the Irvine Company by George Rathmann, its Chairman, for its facility at 985 Almanor Avenue, has consequently been cancelled. The Company has not used any of the funds available under this revolving credit line. The proceeds of a planned initial term loan draw-down of $2.6 million will be used solely to repay the same amount owing to AMB Property, LP. The proceeds of all other term loan draw-downs may be used for the Company’s working capital or other general business requirements. The Company’s

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revolving credit borrowings shall bear interest at Silicon Valley Bank’s prime rate in effect from time to time. Its term loan borrowings under the new loan facility shall bear interest at a fixed rate per annum equal to the 36-month Treasury Rate in effect on the funding date plus three and one-quarter percent (3.25%), and, in any event, shall not be less than 6.43% per annum. As of September 30, 2004, the Company was in compliance with all related covenants and reporting requirements, and the applicable interest rates for the term loan and the revolving credit line were 6.43% and 4.75%, respectively.

6. Licensing and Collaboration Agreements

On January 12, 2004, the Company entered into a worldwide collaboration agreement with Archemix Corporation, also referred to as Archemix, to develop and commercialize ARC183, a thrombin inhibitor that the Company intends to develop for potential use in coronary artery bypass graft, or CABG, surgery, percutaneous coronary intervention, or PCI, and other acute anticoagulant applications that require rapid resolution of anticoagulation or that require reversal of anticoagulation shortly after the procedure is complete. The Company paid Archemix an upfront fee of $3.0 million which was charged to research and development expense in the first quarter of 2004. As of September 30, 2004, the Company has expensed $4.2 million to date for clinical trial costs incurred in 2004 under the terms of the agreement. The Company is also required to make a development milestone payment of $10.0 million upon initiation of a Phase 2 clinical trial of ARC 183 and $1.0 million upon the designation of any backup compound. Under the terms of the collaboration agreement, Archemix is initially responsible for leading development and for all clinical development activities. As part of the agreement, the Company and Archemix equally share all costs associated with the development and commercialization of ARC 183 after the Company has funded the first $4.0 million in research and development costs, and will equally share any revenues associated with its commercialization. Since such research and development costs have already exceeded $4.0 million as of the current quarter, the companies have started the 50/50 cost sharing arrangement. Under the collaboration agreement, the Company has the option to lead commercialization efforts in which both companies may participate. Upon reaching commercialization, both companies are responsible for paying any related royalties to each other depending on product sales volume. An Investigational New Drug, or IND, application for ARC183 was filed in June 2004, and the Company subsequently initiated a Phase 1 clinical trial in August 2004.

On February 4, 2004, the Company entered into a worldwide licensing agreement with Dendreon Corporation for the drug candidate, rNAPc2, and all other rNAPc molecules owned by Dendreon. rNAPc2 is a recombinant version of a naturally occurring protein that has anticoagulant properties. Under the terms of the agreement, the Company paid Dendreon an upfront fee of $4.0 million ($500,000 in cash and $3.5 million in Nuvelo common stock) which was charged to research and development expense in the first quarter of 2004. As of September 30, 2004, total rNAPc2 related clinical trial expenses incurred to date were $1.1 million. The Company is also required to pay Dendreon milestone payments, ranging from $2.0 million to $6.0 million each, for both rNAPc2’s first and second indications upon dosing of the first patient in a Phase 3 clinical trial, submission of a New Drug Application, or NDA, and first commercial sale. Total future payments, if all development and commercialization milestones are achieved, can reach as much as $21.0 million. In addition, the Company will pay Dendreon milestone payments of up to $2.5 million for net sales in excess of certain amounts for rNAPc molecules commercialized for the diagnosis, treatment or prevention of Ebola hemmorrhagic fever. The Company’s license from Dendreon grants it exclusive worldwide rights to all indications for rNAPc products. Upon reaching commercialization, the Company is also responsible for paying future royalties to Dendreon depending on certain sales volume of rNAPc2. In May 2004, the Company re-initiated a Phase 2a double-blind, placebo-controlled clinical trial with rNAPc2 for potential use or in treating acute coronary syndromes, or ACS, including unstable angina, or UA, and non-ST segment elevation myocardial infarction, or NSTEMI.

On January 28, 2004, the Company signed an amended and restated secreted protein development and collaboration agreement with Deltagen, Inc., or Deltagen. The amended agreement grants the Company certain license rights to Deltagen’s knock-out technology. On March 8, 2004, the California Bankruptcy Court approved the amendment to the Company’s agreement with Deltagen. Under the amendment, the Company assigns to Deltagen its rights in 46 of the genes that entered the collaboration and grants Deltagen a non-exclusive license to certain technology arising out of the collaboration related to those 46 genes. In exchange, Deltagen relinquishes any rights it had under the agreement to the other 115 genes that entered the collaboration and grants the Company certain rights to Deltagen’s knock-out technology related to those 115 genes. In addition, Nuvelo and Deltagen granted each other general releases under the amendment with respect to any obligations or activities under the collaborations.

On August 10, 2004, the Company amended its collaboration agreement with the Pharmaceutical Division of Kirin Brewery Company, Ltd., dated August 11, 2001, to extend the agreement through December 31, 2005. Nuvelo and Kirin have expanded the scope of the collaboration to include additional secreted protein genes from Nuvelo’s full-length gene portfolio and are expected to foster further development of therapeutic candidates using Kirin’s proprietary site-directed transgenic mouse technology to identify and develop secreted proteins and associated antibodies with therapeutic utility.

        The Company recognizes clinical trial manufacturing expense when manufacturing is completed and the clinical trial material is shipped from the manufacturing facility to the testing site. Prior to shipment from the clinical trial manufacturing facility, the Company reflects the manufacturing work in process as Clinical Trial Supplies on the accompanying balance sheet in accordance with the Company’s Clinical Trial Manufacturing Expenses and Clinical Trial Supplies Asset policy, described in note #2 above. As of September 30, 2004, the Company has accrued liabilities of $8.3 million for clinical trial manufacturing performed by Amgen, recorded total Clinical Trial Supplies assets of $12.7 million for clinical trial supplies not yet shipped, and expensed $0.6 million for clinical trial manufacturing materials shipped by Amgen to our clinical sites. As of September 30, 2004 the Company has paid Amgen $4.4 million under the agreement.

On October 29, 2004, Amgen Inc., exercised its rights under the collaboration agreement entered into by the Company and Amgen on January 8, 2002, to convert the relationship from a collaboration into a licensing arrangement in accordance with terms agreed upon by the Company and Amgen. On November 3, 2004, the Company and Amgen entered into a license agreement granting the Company exclusive worldwide rights to develop and commercialize alfimeprase in exchange for payment of milestones and royalties of which the amounts were previously negotiated. Under the terms of the license agreement, Amgen will transfer the technology necessary for the manufacture of alfimeprase to the Company or a manufacturer acceptable to Amgen. Amgen is required to continue to supply alfimeprase to the Company during the transition period. On November 1, 2004, the Company paid Amgen a total of $8.5 million under an Opt-Out, Termination, Settlement and Release Agreement entered into by Amgen and the Company on October 29, 2004, as part of the finalization of the license agreement, of which $8.3 million was related to the remaining reimbursement of its manufacturing costs incurred under the collaboration agreement. In addition, the Company is required to pay Amgen a milestone payment of $5.0 million upon dosing of the first patient in the first Phase 3 clinical trial for alfimeprase, which the Company expects will occur in the first quarter of 2005. Total future milestone payments for development and commercialization, inclusive of this upcoming $5.0 million payment, can potentially reach as much as $50.0 million. Upon reaching commercialization, if this ever occurs, the Company is also responsible for paying royalties to Amgen depending on alfimeprase’s sales volume in certain territories.

7. Segment Information

The Company has two reportable segments: Nuvelo and Callida Genomics. Reportable segments reflect the Company’s structure, reporting responsibilities to the chief executive officer and the nature of the products under development. Nuvelo develops and intends to market therapeutic drugs for the treatment of human diseases. Callida Genomics develops and intends to commercialize the sequencing-by-hybridization, or SBH, technology including DNA sequencing chip. Segment operating results are measured based on net loss before tax. There are no inter-segment sales.

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RECONCILIATION OF REPORTABLE SEGMENTS’ FINANCIAL INFORMATION

(in thousands)

The primary source of the Nuvelo segment revenues in the third quarters of 2004 and 2003 was royalties from sublicensing of Human Methylenetetrahydrofolate Reductase, or MTHFR, technology. The primary sources of Callida segment revenues in the third quarters of 2004 and 2003 were from a National Institute of Standards and Technology, or NIST, grant and the National Institute of Health, or NIH, grants.

8. Recent Accounting Pronouncements

On March 31, 2004, the FASB issued “Share-Based Payment”, an amendment of Statement No. 123 and 95 (Proposed Statement of Accounting Standards) that addresses the accounting for share-based awards to employees, including employee stock purchase plans, or ESPPs. The FASB formally proposed to require companies to recognize as an expense the fair value of stock options and other stock-based compensation to employees. The proposed statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and would require instead, that such transactions be accounted for using a fair-value-based method, a measurement method which will be selected upon the adoption of this proposed statement to fairly value the Company’s stock options and recognize that value as an expense. The proposed requirements in the exposure draft would be effective for public companies as of the beginning of the first fiscal quarter after June 15, 2005. The Company currently accounts for its stock-based compensation plans in accordance with APB Opinion No. 25. Therefore, the adoption of this proposed statement, if issued in final form by the FASB, will have a material effect on the Company’s consolidated financial statements, specifically, the consolidated statements of operations and stockholders’ equity (deficit).

9. Contingency

The Company is currently in a dispute with two former employees regarding stock options granted to them in 1994. The Company’s position is that the stock options have expired. The former employees allege that the stock options are exercisable. As of October 25, 2004, no legal action has been taken by the former employees or the Company, and the Company is not able to make an estimate of any potential liability at this time.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words including “will,” “anticipate,” “believe,” “intends,” “estimates,” “expect,” “should,” “may,” “potential” and similar expressions. Such statements are based on our management’s current expectations and involve risks and uncertainties. Actual results and performance could differ materially from those projected in the forward-looking statements as a result of many factors discussed herein and elsewhere including, in particular, those factors described under the “Risk Factors” set forth below, and in our other periodic reports filed from time to time with the Securities and Exchange Commission, or SEC. Actual results and performance could also differ materially from time to time from those projected in our filings with the SEC.

Overview

We are strategically focused on the discovery, development and commercialization of life improving therapeutics for the treatment of acute cardiovascular indications and cancer. As part of this plan, we intend to dedicate our resources to advancing our most promising biopharmaceutical discovery and development programs, including our lead product candidate alfimeprase, which recently completed two Phase 2 trials in acute peripheral arterial occlusion, or PAO, and catheter occlusion; rNAPc2, an anticoagulant which is currently in a Phase 2a clinical trial for acute coronary syndromes, or ACS; and ARC183, an anti-thrombin aptamer that is being developed as an anticoagulant/anti-thrombotic for potential use in coronary artery bypass graft, or CABG, surgery, which began a Phase 1 trial in August 2004.

In addition, we intend to leverage our proprietary gene collection and expertise in secreted proteins and antibody targets to identify additional candidates for internal development or collaboration opportunities. We will also continue to employ an opportunistic in-licensing and collaboration strategy to build upon our pipeline of attractive therapeutic candidates.

Alfimeprase, our lead product candidate, is a thrombolytic agent, or blood clot dissolver. Alfimeprase is currently under investigation in two indications, acute peripheral arterial occlusion, or PAO, and catheter occlusion. On June 28, 2004, enrollment in a Phase 2 study testing the safety and activity of alfimeprase in 113 acute PAO patients was completed. Clinical data from this trial was presented at the 2004 Transcatheter Cardiovascular Therapeutics Scientific Symposium indicating that alfimeprase was generally safe and well tolerated. Dependent upon discussions with the FDA regarding the design of our planned Phase 3 trial and our decision regarding application for a special protocol assessment, or SPA, we expect to begin a Phase 3 PAO trial in the first quarter of 2005.

On July 12, 2004, Nuvelo concluded a Phase 2 study in central venous catheter occlusion. The results of this Phase 2 study will be presented in a poster presentation at the upcoming American Society of Hematology Annual Meeting in December 2004. We intend to work with the FDA to design a trial focused on obtaining approval in this indication.

On October 29, 2004, Amgen Inc., exercised its rights under the collaboration agreement entered into by us and Amgen on January 8, 2002, to convert the relationship from a collaboration into a licensing arrangement in accordance with terms agreed upon by us and Amgen. On November 3, 2004, we and Amgen entered into a license agreement granting us exclusive worldwide rights to develop and commercialize alfimeprase in exchange for payment of milestones and royalties of which the amounts were previously negotiated. Under the terms of the license agreement, Amgen will transfer the technology necessary for the manufacture of alfimeprase to us or a manufacturer acceptable to Amgen. Amgen is required to continue to supply alfimeprase to us during the transition period. As part of finalizing this license agreement, on November 1, 2004, we paid Amgen $8.5 million under an Opt-Out, Termination, Settlement and Release Agreement entered into by Amgen and us on October 29, 2004, as part of the finalization of the license agreement, of which $8.3 million was related to the remaining reimbursement of its manufacturing costs incurred under the collaboration agreement. In addition, we are also required to pay Amgen a milestone payment of $5.0 million upon dosing of the first patient in the first Phase 3 clinical trial for alfimeprase, which we expect will occur in the first quarter of 2005. Total future milestone payments for development and commercialization, inclusive of this upcoming $5.0 million payment, can potentially reach as much as $50.0 million. Upon reaching commercialization, if this ever occurs, we are also responsible for paying royalties to Amgen depending on alfimeprase’s sales volume in certain territories.

        On January 12, 2004, we entered into a worldwide collaboration agreement with Archemix Corporation to develop and commercialize ARC183, a thrombin inhibitor, that we intend to develop for potential use in CABG surgery, and possibly for percutaneous coronary intervention, or PCI, and other acute anti-coagulant applications that require rapid resolution of anticoagulation or that require reversal of anticoagulation shortly after the procedure is completed. Under the terms of our agreement, we paid Archemix an upfront fee of $3.0 million in cash, and as of September 30, 2004, have expensed $4.2 million for clinical trial costs incurred in 2004 under the terms of the agreement. Under the terms of the collaboration agreement, Archemix is initially responsible for leading development and for all clinical development activities. As part of the agreement, we and Archemix equally share all costs associated with the development and commercialization of ARC 183 after we have funded the first $4.0 million in research and development costs, and will jointly share any revenues resulting from its commercialization. Since these joint research and development costs have already exceeded $4.0 million as of the current quarter, we and Archemix have started the 50/50 cost sharing arrangement. Under the collaboration agreement, we have the option to lead commercialization efforts in which both we and Archemix may participate. An Investigational New Drug, or IND, application for ARC183 was filed in June 2004, and we subsequently initiated a Phase 1 clinical trial in August 2004. We are required to pay Archemix development milestone payments of $10.0 million upon commencement of a Phase 2 trial and $1.0 million upon the designation of any backup compound selected by both Nuvelo and Archemix for IND-enabling studies. We are obligated to make the Phase 2 milestone payment to Archemix even if the collaboration is terminated by Archemix, or if Archemix does not meet its obligations under the agreement and we terminate the collaboration for default by Archemix. Upon reaching commercialization, both companies are responsible for paying any related royalties to each other depending on product sales volume. We believe neither of the milestones will be reached within the next twelve months if ever.

On February 4, 2004, we entered into a worldwide licensing agreement with Dendreon Corporation for the drug candidate rNAPc2, and all other rNAPc molecules owned by Dendreon. rNAPc2 is a recombinant version of a naturally occurring protein that has anticoagulant properties. Under the terms of the agreement, we paid Dendreon an upfront fee of $4.0 million ($500,000 in cash and $3.5 million in Nuvelo common stock) and as of September 30, 2004, have incurred year-to-date clinical trial expenses of $1.1 million related to the rNAPc2 project. We are required to pay Dendreon milestone payments, ranging from $2.0 million to $6.0 million each, for both rNAPc2’s first and second indications upon dosing of the first patient in a Phase 3 clinical trial, upon submission of a New Drug Application, or NDA, and upon first commercial sale. If all development and commercialization milestones are achieved, total milestone payments to Dendreon can reach as much as $21.0 million. In addition, we will pay Dendreon milestone payments of up to $2.5 million for net sales in excess of certain amounts for rNAPc molecules commercialized for the diagnosis, treatment or prevention of Ebola hemmorrhagic fever. We believe that achieving these milestones is uncertain and expect none of the milestones to be achieved within the next twelve months, if ever. Our license from Dendreon grants us exclusive worldwide rights to all indications for rNAPc products. Upon reaching commercialization, we are also responsible for paying future royalties to Dendreon depending on certain sales volume of rNAPc2. We are currently investigating rNAPc2 in a Phase 2a double-blind, placebo-controlled clinical trial for potential use in treating acute coronary syndromes, or ACS, including unstable angina, or UA, and non-ST segment elevation myocardial infarction, or NSTEMI.

On August 10, 2004, the Company amended its Collaboration Agreement with Kirin Brewery Company, Ltd., dated August 11, 2001, to extend through December 31, 2005. Nuvelo and Kirin have expanded the scope of the collaboration to include additional secreted protein genes from its full-length gene portfolio.

Our efforts to manage simultaneously a number of collaboration and licensing arrangements may not be successful, and the failure to manage effectively such

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collaborations would significantly harm our business, financial condition and results of operations. Due to these factors and other possible disagreements with Amgen, Archemix, Dendreon and Kirin, we may be delayed or prevented from developing or commercializing alfimeprase, ARC183 and rNAPc2 or our pre-clinical product candidates or we may become involved in litigation or arbitration, which would be time-consuming or expensive and could have a material adverse effect on our stock price.

RESULTS OF OPERATIONS

Contract Revenues

Comparison of the Three and Nine Months Ended September 30, 2004 and 2003.

Revenues increased by $0.4 million to $0.7 million for the three months ended September 30, 2004, up from $0.3 million for the comparable period ended September 30, 2003, due to increased grant revenue of $0.4 million from the National Institute of Standards and Technology’s, or NIST’s, Advanced Technology Program, and from the National Institute of Health, or NIH.

Revenues increased by $0.3 million to $2.2 million for the nine months ended September 30, 2004, up from $1.9 million for the comparable period ended September 30, 2003. This net increase is primarily due to an increase of $1.1 million in new grant revenue earned from the NIH, as offset by a decrease in revenues due to the completion of recognition of license fee revenues of $0.5 million associated with our collaboration with Affymetrix, Inc., for the development of a high speed universal DNA sequencing chip which was completed in the first quarter of 2003 as well as the completion of recognition of license fee revenues of $0.3 million from the Celera Diagnostics collaboration in the second quarter of 2003.

Revenues earned by our Nuvelo segment were less than $0.1 million for the three months ended September 30, 2004, and $0.2 million for the nine months ended September 30, 2004, compared to $0.1 million for the three months ended September 30, 2003 and $1.0 million for the nine months ended September 30, 2003. Our Callida segment had revenues of $0.6 million for the three months ended September 30, 2004 and $2.1 million for the nine months ended September 30, 2004, compared to $0.2 million for the three months ended September 30, 2003 and $0.9 million for the nine months ended September 30, 2003. We anticipate that revenues will remain small as we continue to focus on clinical development and work toward the commercialization of our clinical stage product candidates, alfimeprase, rNAPc2 and ARC183.

Our revenues typically vary from quarter to quarter and may result in significant fluctuations in our operating results from year to year. In the future, we may not be able to maintain existing collaborations, obtain additional collaboration partners or obtain revenue from other sources. The failure to maintain existing collaborations or the inability to enter into additional collaborative arrangements or obtain revenues from other sources could have a material adverse effect on our revenues, operating results, and cash flow.

Operating Expenses

Comparison of the Three Months and Nine Months Ended September 30, 2004 and 2003.

Research and development, or R&D, expenses consist of personnel costs and other R&D related operating expenses predominantly covering clinical trial and drug manufacturing costs, supplies, outside services, licenses and royalty fees, depreciation and amortization, and facilities expenses. Total R&D expenses increased to $8.7 million for the three months ended September 30, 2004, compared to $8.3 million for the comparable period ended September 30, 2003. The net increase of $0.4 million was primarily due to additional research support costs incurred to support the NIH and NIST grants.

Research and development expenses increased to $34.8 million for the nine months ended September 30, 2004 from $26.4 million for the comparable period ended September 30, 2003. The increase was primarily due to an increase of $6.8 million in license fee expenses primarily related to our new licensing/collaboration agreements signed with Archemix and Dendreon, as well as an increase of $3.9 million in overall clinical trial and research-related costs to continue supporting development of our current drug candidates, partially offset by $2.0 million in savings realized during the nine months ended September 30, 2004 from completion of the shut-down of our Variagenics operations in the third quarter of 2003. R&D expenses included in the statements of operations in the nine months ended September 30, 2004 and since inception for our significant programs are as follows (including license and collaboration fees):

The timing, cost of completing the clinical development of any product candidate, and any potential future product revenues will depend on a number of factors, including the disease or medical condition to be treated, clinical trial design and endpoints, availability of patients to participate in trials and the relative efficacy of the product versus treatments already approved. Due to these uncertainties, we are unable to estimate the length of time or the costs that will be required to complete the development of these product candidates. We don’t expect to generate any sales revenue until we reach the commercialization stage for any of our drug products, if this ever occurs.

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General and administrative expenses remained virtually unchanged, with a decrease of $0.1 million to $2.8 million for the three months ended September 30, 2004, compared to $2.9 million for the comparable period ended September 30, 2003.

General and administrative expenses decreased to $6.7 million for the nine months ended September 30, 2004 from $14.4 million for the comparable period ended September 30, 2003. The decrease was primarily due to $4.5 million in lease termination and related expenses in connection with management’s decision not to exercise the Humboldt Court facility purchase option and $3.0 million in savings realized during the nine months ended September 30, 2004 from completion of the shut-down of our Variagenics’ operations, offset by various increases in corporate costs, such as legal and accounting expenses, associated with new license/collaboration agreements entered in the current year, our re-incorporation into Delaware and our ongoing efforts to implement company-wide internal controls documentation and testing procedures as required under the Sarbanes-Oxley Act of 2002.

Our Nuvelo segment had operating expenses of $10.3 million for the three months ended September 30, 2004 and $38.0 million for the nine months ended September 30, 2004, compared to $9.9 million for the three months ended September 30, 2003 and $37.6 million for the nine months ended September 30, 2003. Our Callida segment had operating expenses of $1.2 million for the three months ended September 30, 2004 and of $3.5 million for the nine months ended September 30, 2004, compared to $1.0 million for the three months ended September 30, 2003 and to $4.4 million for the nine months ended September 30, 2003.

In addition to our upfront payments made in connection with ARC 183 and rNAPc2 in the first quarter of 2004, we expect total operating expenses to increase for the remainder of 2004 for clinical development costs as we continue to advance our drug candidates, alfimeprase, rNAPc2, and ARC183 through clinical trials. We expect to expense $12.7 million of drug manufacturing costs within the next twelve months as we start to advance alfimeprase into Phase 3 clinical trials in the near future. We also are required to pay Amgen a milestone payment of $5.0 million upon dosing of the first patient in the first phase 3 clinical trial for alfimeprase, which we expect will occur in the first quarter of 2005, resulting from the license agreement signed on November 3, 2004. We currently do not expect to incur any milestone expense for our rNAPc2 and ARC183 drug candidates in the next twelve months.

Interest Income and Expense

Comparison of the Three Months and Nine Months Ended September 30, 2004 and 2003.

Our net interest expense decreased to $21,000 during the three months ended September 30, 2004 and to $239,000 during the nine months ended September 30, 2004, from $310,000 during the three months ended September 30, 2003 and from $760,000 during the nine months ended September 30, 2003. The decrease in net interest expense is related to increased interest income primarily due to higher average cash and investment balances from financing activities in October 2003 and March 2004, which were offset by increased interest expense related to the amortization of premiums associated with corporate debt securities held to maturity in our short-term investment account.

Net Loss

Comparison of the Three Months and Nine Months Ended September 30, 2004 and 2003.

Since inception we have incurred operating losses, and as of September 30, 2004, we had an accumulated deficit of $243.1 million. We incurred a net loss of $10.9 million for the three months ended September 30, 2004 and of $39.5 million for the nine months ended September 30, 2004, compared to a net loss of $10.9 million for the three months ended September 30, 2003 and of $40.8 million for the nine months ended September 30, 2003. Our Nuvelo segment had net losses of $10.3 million for the three months ended September 30, 2004 and of $38.1 million for the nine months ended September 30, 2004, compared to net losses of $10.1 million for the three months ended September 30, 2003 and of $37.3 million for the nine months ended September 30, 2003. Callida had net losses of $0.6 million for the three months ended September 30, 2004 and of $1.4 million for the nine months ended September 30, 2004, as compared to losses of $0.8 million for the three months ended September 30, 2003 and of $3.5 million for the nine months ended September 30, 2003.

The decreased net loss in the nine months ended September 30, 2004 as compared to the nine months ended September 30, 2003, resulted primarily from decreased general and administrative expenses, depreciation expenses, the loss on sale of certain assets in 2003, and savings realized from Variagenic’s shut-down in 2003 as compared to the nine months ended September 30, 2003, which were partially offset by increased license expenses incurred in connection with worldwide license fees and development expenses paid relating to our rNAPc2 and ARC183 drug candidates. We expect to continue to incur significant operating losses for the foreseeable future, which may increase substantially as we continue clinical development of our lead drug candidate, alfimeprase, continue clinical development of rNAPc2 and ARC183, further expand research and development of our potential biopharmaceutical product candidates, potentially in-license other drug candidates, and continue to prosecute and enforce our intellectual property rights.

LIQUIDITY AND CAPITAL RESOURCES

To date our primary source of liquidity has been cash from financing activities, collaboration receipts and our merger with Variagenics on January 31, 2003. We believe that we have adequate cash reserves to fund our operations through 2005.

In a public offering completed on March 8, 2004, we raised approximately $69.5 million, net of total underwriters’ fees and stock issuance costs of $5.3 million, from the sale of 5,750,000 shares of our common stock, including 750,000 shares related to the exercise of an over-allotment option granted to the underwriters, at a public offering price of $13.00 per share. We intend to use the net proceeds for general corporate purposes, including capital expenditures, and to meet working capital needs. We expect from time to time to evaluate the acquisition of businesses, products and technologies for which a portion of the net proceeds may be used.

On August 31, 2004, we entered into a Loan and Security Agreement, or Loan Agreement, with Silicon Valley Bank that provides us with a $4,000,000 revolving credit line and a $6,000,000 term loan facility and grants Silicon Valley Bank a security interest over certain of our assets, excluding intellectual property. As a condition precedent to the Loan Agreement, we agreed, among other things, to certain covenants and reporting requirements. The proceeds of the revolving credit line will be used solely for our working capital and other general business requirements, and our existing letter of credit issued to the Irvine Company by George Rathmann, our Chairman, for our facility at 985 Almanor Avenue, has consequently been cancelled. We have not used any of the funds available under this revolving credit line. The proceeds of a planned initial term loan draw-down of $2.6 million will be used solely to repay the same amount owing to AMB Property, LP. The proceeds of all other

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term loan draw-downs may be used for our working capital or other general business requirements. Our revolving credit borrowings shall bear interest at Silicon Valley Bank’s prime rate in effect from time to time. Our term loan borrowings under the new loan facility shall bear interest at a fixed rate per annum equal to the 36-month Treasury Rate in effect on the funding date plus three and one-quarter percent (3.25%), and, in any event, shall not be less than 6.43% per annum. As of September 30, 2004, we were in compliance with all related covenants and reporting requirements, and the applicable interest rates for the term loan and the revolving credit line were 6.43% and 4.75%, respectively.

Cash and Cash Equivalents, Short-Term Investments, and Restricted Cash on Deposit

As of September 30, 2004, we had $70.7 million in cash, cash equivalents and short-term investments. This amount reflects a net increase of $36.5 million from $34.2 million as of December 31, 2003. This increase resulted from cash provided by the sale of common stock through financing activities completed in March 2004, as partially offset by cash consumed by our operations during the year.

In addition, we had $0.2 million in total restricted cash on deposit as of September 30, 2004. This restricted cash is security for a letter of credit in conjunction with a facility lease for our office at 675 Almanor Avenue in Sunnyvale, California, which terminates on June 30, 2005. The cash on deposit in conjunction with this letter of credit is restricted and cannot be withdrawn. We control the investment of the restricted cash and receive the interest earned thereon.

The primary objectives for our investment portfolio are liquidity and safety of principal. Investments are made to achieve the highest rate of return to us, consistent with these two objectives. Our investment policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings and places restrictions on maturities and concentration by type and issuer.

Cash Used in Operating Activities

Net cash used in operating activities decreased $2.4 million to $31.2 million in the first nine months of 2004, compared to $33.6 million during the same period in 2003. The decrease in cash used in operating activities was primarily due to the reduction in 2004 of expenses incurred as part of our merger with Variagenics in the first nine months of 2003, which were eliminated last year, and was partially offset by increased license fees of $3.5 million paid in connection with license agreements and increased manufacturing and development costs of $7.6 million paid to Archemix and Amgen as reimbursement for our ARC183 clinical development costs and drug manufacturing costs for our lead product candidate, alfimeprase.

We expect an increase in operating expenses in the fourth quarter of 2004 and in 2005, as we continue to incur increased clinical development and manufacturing costs related to our three drug candidates. We have incurred liabilities of $8.3 million for the manufacture of alfimeprase for use in Phase 2 and Phase 3 trials and $1.0 million for our collaboration from Archemix, all of which we expect to be paid in the fourth quarter of 2004. In addition, we are required to pay Amgen a milestone payment of $5.0 million upon dosing of the first patient in the first Phase 3 clinical trial for alfimeprase, which we expect will occur in the first quarter of 2005, as part of the license agreement signed on November 3, 2004. If we are successful in reaching the commercialization stage, we will also be responsible for paying our collaboration and licensing partners certain product royalties, depending on product sales volumes. We do not foresee a significantly negative impact in our liquidity based on potential royalty payment obligations, as the majority of these payments are related to commercial sales, which provide us with offsetting cash inflows. Our future milestone payments under current agreements could total $84.5 million if all milestones are achieved which would significantly affect our future cash flows. Only $5.0 million of this amount is expected to be paid within the next twelve months, as noted above.

Cash Used in / Provided by Investing Activities

Net cash used in investing activities was $48.2 million during the first nine months of 2004, compared to $45.1 million of net cash provided by investing activities during the comparable period ended September 30, 2003. The increased use of cash from the nine months ended September 30, 2004, as compared to the nine months ended September 30, 2003 was primarily due to increased purchases of short-term investments as a result of cash raised from the public offering completed in March 2004, offset by a reduction in cash received due to the acquisition of Variagenics in 2003. Other than purchases and sales of short-term investments, we expect net cash used in investing activities to stay at a low level for the foreseeable future.

Cash Provided by Financing Activities

        We generated cash of $68.3 million and $0.1 million from financing activities in the first nine months of 2004 and 2003, respectively. Net cash provided by financing activities for Nuvelo in the nine months ended September 30, 2004, resulted from a public offering completed on March 8, 2004, from the exercise of stock options, the employee stock purchase plan, and a decrease in the restricted cash associated with one of our facilities, which was partially offset by payments made on our lease and loan obligations. Net cash provided by financing activities in the nine months ended September 30, 2003, was due to additional funds drawn from our line of credit made available to us by the chairman of our board of directors, the exercise of stock options and the employee stock purchase plan, as partially offset by payments made on our lease obligations and increased cash restricted for letters of credit. The remaining line of credit from our chairman has expired, and we have begun paying down this line of credit through a plan of 48 monthly installments that started in November 2003. There was no cash generated by financing activities in the first nine months of 2004 or 2003 by our Callida segment.

As of September 30, 2004, 576,376 shares of our common stock were issuable upon repayment of a note held by Affymetrix. Affymetrix has the ability to declare all outstanding principal and interest under the note immediately due and payable if our market capitalization is under $50 million and Affymetrix reasonably determines that the loan evidenced by the note is impaired, and we have an obligation to prepay amounts owing under the note to the extent that the amounts outstanding exceed 10% of our market capitalization. Moreover, we have registered for resale a portion of these shares on a registration statement that has been declared effective by the SEC.

Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth under “Risk Factors” below. We may not be able to secure additional financing to meet our funding requirements on acceptable terms, if at all. If we raise additional funds by issuing equity securities, substantial dilution to our existing stockholders may result. If we are unable to obtain additional funds, we may have to additionally curtail the scope of our operations.

Operating Leases

As of September 30, 2004, we are leasing three facilities under operating lease agreements, two of which expire in June 2005 and one that expires in May 2011. There are no changes in any lease agreements since the filing of our Form 10-Q on August 9, 2004 for the quarter ended June 30, 2004. The rent is being recognized as an expense on a straight-line basis.

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Our minimum future rental commitments under non-cancelable operating leases at September 30, 2004 are as follows (in thousands):

Critical Accounting Policies and Estimates

Our discussion and analysis of our operating results and financial condition is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of the financial statements requires us to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent amounts. While we believe our estimates, judgments, and assumptions are reasonable, the inherent nature of estimates is such that actual results will likely be different from the estimates made.

In addition to the critical accounting policies presented in our Annual Report on Form 10-K for the year ended December 31, 2003, as filed on March 12, 2004, we apply the following policy.

Clinical Trial Manufacturing Expense and Clinical Trial Supplies Asset

We recognize clinical trial manufacturing expense when the clinical trial material is shipped from the manufacturing facility to the testing site. In accordance with FASB Statement of Financial Accounting Standards (SFAS) No. 2 Accounting for Research and Development Costs, we have accounted for this clinical trial material as Clinical Trial Supplies, a current asset on our balance sheet as there are alternative future uses for the supply in other indications not currently being studied, including deep vein thrombosis, stroke, acute myocardial infarction and pulmonary embolism. On a quarterly basis we evaluate if there continues to be alternative future use for the alfimeprase clinical drug material. Any unconsumed clinical trial supplies will be expensed as research and development in the quarter in which there ceases to exist a future alternative use.

NEW ACCOUNTING PRONOUNCEMENTS

On March 31, 2004, the FASB issued “Share-Based Payment” an amendment of Statement No. 123 and 95 (Proposed Statement of Accounting Standards) that addresses the accounting for share-based awards to employees, including employee stock purchase plans, or ESPPs. The FASB formally proposed to require companies to recognize as an expense the fair value of stock options and other stock-based compensation to employees. The proposed statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally would require instead that such transactions be accounted for using a fair-value-based method, a measurement method which will be selected upon the adoption of this proposed statement to fairly value our stock options and recognize that value as an expense. The proposed requirements in the exposure draft would be effective for public companies as of the beginning of the first fiscal quarter after June 15, 2005. We currently account for our stock-based compensation plans in accordance with APB Opinion No. 25. Therefore, the adoption of this proposed statement, if issued in final form by the FASB, will have a material effect on our consolidated financial statements, specifically, the consolidated statements of operations and stockholders’ equity (deficit).

RISK FACTORS

We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. The following discussion highlights some of these risks.

RISKS RELATING TO OUR BUSINESS

Development of our products will take years, and our products require regulatory approval before they can be sold.

        We have three clinical stage drug candidates. All of our other potential products currently are in research or preclinical development and revenues from the sales of any products resulting from these efforts may not occur for several years, if at all. We cannot be certain that any of our products will be demonstrated to be safe and effective or that we will obtain regulatory approvals. We cannot predict whether we will be able to develop and commercialize any of our drug candidates successfully. If we are unable to obtain regulatory approval and successfully commercialize our potential products, our business, results of operations and financial condition will be affected in a materially adverse manner.

We do not yet have products in the commercial markets. We must demonstrate that our product candidates satisfy rigorous standards of safety and efficiency before the FDA and comparable agencies in foreign markets. We cannot apply for regulatory approval of our potential products until we have performed significant additional research and development and testing. We cannot be certain that we, or our strategic partners, will be permitted to undertake clinical testing of our potential products or continue clinical testing of alfimeprase, rNAPc2, or ARC183. If we are successful in initiating clinical trials, we may experience delays in conducting them. Our clinical trials may not demonstrate the safety and efficacy of our potential products, and we may encounter unacceptable side effects or other problems in the clinical trials that may prevent or limit the use of our products. Should this occur, we may have to delay or discontinue development of the potential product that causes the problem. After a successful clinical trial, we cannot market products in the United States until we receive regulatory approval. Even if we are able to gain regulatory approval of our products after successful clinical trials and then commercialize and sell those products, we may be unable to manufacture enough products to maintain our business, which could have a negative impact on our financial condition.

Our clinical trials may not yield results that will enable us to obtain regulatory approval for our products.

We will only receive regulatory approval for a drug candidate if we can demonstrate in carefully designed and conducted clinical trials that the drug candidate is safe and effective. We do not know whether our pending or any future clinical trials will demonstrate sufficient safety and efficacy to obtain the requisite regulatory approvals or will result in marketable products. Clinical trials are lengthy, complex, and expensive processes with uncertain results. It will take us several years to

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complete our testing, and failure can occur at any stage of testing. Results attained in preclinical testing and early clinical studies, or trials, may not be predictive of results that are obtained in later studies. We may suffer significant setbacks in advanced clinical trials, even after promising results in earlier studies. Based on results at any stage of clinical trials, we may decide to repeat or redesign a trial or discontinue development of one or more of our drug candidates. If we fail to adequately demonstrate the safety and efficacy of our products under development, we will not be able to obtain the required regulatory approvals to commercialize our drug candidates, and our business, results of operations and financial condition will be materially adversely affected.

Clinical trials are subject to continuing oversight by governmental regulatory authorities and institutional review boards, or IRBs, and must meet the requirements of these authorities in the United States, including those for informed consent and good clinical practices. We may not be able to comply with these requirements and the FDA, an IRB or we may suspend or terminate clinical trials at any time.

Administering our drug candidates to humans may produce undesirable side effects. These side effects could interrupt, delay or halt clinical trials of our drug candidates and could result in the FDA or other regulatory authorities denying approval of our drug candidates for any or all targeted indications.

We rely on third parties, including contract research organizations and outside consultants, to assist us in managing and monitoring clinical trials. Our reliance on these third parties may result in delays in completing, or in failing to complete, these trials if they fail to perform with the speed and competency we expect.

If clinical trials for a drug candidate are unsuccessful, we will be unable to commercialize the drug candidate. If one or more of our clinical trials are delayed, we will be unable to meet our anticipated development or commercialization timelines. Either circumstance could cause the price of our shares to decline.

If we encounter difficulties enrolling patients in our clinical trials, our trials could be delayed or otherwise adversely affected.

Clinical trials for our drug candidates require that we identify and enroll a large number of patients with the disorder under investigation. We may not be able to enroll a sufficient number of patients to complete our clinical trials in a timely manner.

Patient enrollment is affected by factors including:

If we have difficulty enrolling a sufficient number of patients to conduct our clinical trials as planned, we may need to delay or terminate ongoing or planned clinical trials, either of which would have a negative effect on our business.

We face heavy government regulation, and FDA regulatory approval of our products is uncertain.

The research, testing, manufacturing and marketing of drug products such as those proposed to be developed by us or our collaboration partners are subject to extensive regulation by federal, state and local governmental authorities, including the FDA, and comparable agencies in other countries. To obtain regulatory approval of a drug product, we or our collaboration partners must demonstrate to the satisfaction of the applicable regulatory agency, among other things, that the product is safe and effective for its intended uses. In addition, we must show that the manufacturing facilities used to produce the products are in compliance with current Good Manufacturing Practices, or cGMP, requirements.

The process of obtaining FDA and other required regulatory approvals and clearances typically takes several years and will require us to expend substantial capital and resources. Despite the time and expense expended, regulatory approval is never guaranteed. The number of preclinical and clinical tests that will be required for FDA approval varies depending on the drug candidate, the disease or condition that the drug candidate is in development for, and the regulations applicable to that particular drug candidate. The FDA can delay, limit or deny approval of a drug candidate for many reasons, including:

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Moreover, if and when our products do obtain such approval or clearances, the marketing, distribution and manufacture of such products would remain subject to extensive ongoing regulatory requirements. Failure to comply with applicable regulatory requirements could result in:

Any delay or failure by us or our collaboration partners to obtain regulatory approvals for our product candidates:

Even if we do receive regulatory approval for our drug candidates, the FDA or international regulatory authorities may impose limitations on the indicated uses for which our products may be marketed, subsequently withdraw approval or take other actions against us or our products adverse to our business. The FDA and international regulatory authorities generally approve products for particular indications. If an approval is for a limited indication, this limitation reduces the size of the potential market for the product. Product approvals, once granted, may be withdrawn if problems occur after initial marketing.

We also are subject to numerous federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals, the environment and the use and disposal of hazardous substances used in connection with our discovery, research and development work, including radioactive compounds and infectious disease agents. In addition, we cannot predict the extent of government regulations or the impact of new governmental regulations that might significantly harm the discovery, development, production and marketing of our products. We may be required to incur significant costs to comply with current or future laws or regulations, and we may be adversely affected by the cost of such compliance.

If we fail to maintain existing third-party arrangements and collaborative agreements or fail to develop new collaborative arrangements, our business will be harmed.

The success of our business is dependent, in significant part, upon our ability to enter into multiple collaboration agreements and to manage effectively the numerous issues that arise from such arrangements. Management of our relationships with these third parties has required and will require:

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On October 29, 2004, Amgen Inc., exercised its rights under the collaboration agreement entered into by us and Amgen on January 8, 2002, to convert the relationship from a collaboration into a licensing arrangement in accordance with terms agreed upon by us and Amgen. On November 3, 2004, we and Amgen entered into a license agreement granting us worldwide rights to develop and commercialize alfimeprase in exchange for payment of previously negotiated development milestones and royalties. Under the terms of the license agreement, Amgen will transfer the technology necessary for the manufacture of alfimeprase to us or a manufacturer acceptable to Amgen. Amgen is required to continue to supply alfimeprase to us during the transition period. While we currently believe we have enough supplies of alfimeprase for phase 3 trials for the treatment of PAO and catheter occlusion, we cannot be certain that additional supplies will not be necessary, and we have yet to contract for the manufacture of additional supplies of alfimeprase. Even if we do find a manufacturer that can produce alfimeprase in the quantities and with the quality we need for our clinical trials, we cannot be certain that we will be able to reach agreement upon commercially reasonable terms for alfimeprase’s manufacture. If we are unable to find a manufacturer, or manufacturers, to produce alfimeprase in the quantities and with the quality we need, at a commercially reasonable price, we may incur significant, additional expenses and our efforts to complete our clinical trials and obtain FDA approval to market alfimeprase could be significantly delayed.

In our collaboration with Archemix, we share equally all research and developments costs and revenues after we fund the first $4.0 million in research and development costs. We will make milestone payments of $10.0 million upon commencement of a Phase 2 trial and $1.0 million upon the designation of any backup compound selected by both Nuvelo and Archemix for IND-enabling studies. We are obligated to make the Phase 2 milestone payment to Archemix even if the collaboration is terminated by Archemix or Archemix does not meet its obligations under the agreement and we terminate the collaboration for default by Archemix. We have the option to lead commercialization in which both parties may participate if we establish commercialization capabilities; however, if we do not establish such commercialization capabilities, Archemix or a third party selected by the parties’ joint steering committee will have the option to lead commercialization. We do not currently have established commercialization experience or an internal trained sales force and we may not successfully develop such capabilities without incurring additional expenses. If we cannot develop an internal sales force, we will not be able to lead commercialization activities on our own. If we do not lead the commercialization efforts, we are dependent on Archemix or a third party’s experience in commercialization and ability to perform and we may also incur additional expenses for a third party to undertake commercialization efforts.

We are subject to a number of additional risks associated with our collaboration with Archemix for ARC183, including the right of Archemix to terminate its collaboration with us on limited notice and for reasons outside our control, and to the loss of significant rights if the collaboration is terminated because we fail to meet our obligations under it or we elect to terminate for our convenience. In particular, if we terminate the collaboration or if Archemix terminates for our breach, all of our rights to ARC183 and other collaboration products will become the property of Archemix, and we may not practice certain activities related to anti-thrombin compounds in the field of modifying blood-clotting times in therapeutic applications through the use of aptamers such as ARC183, including research and development, manufacturing and commercialization activities.

In our licensing arrangement with Dendreon relating to rNAPc2, we are obligated to make milestone payments ranging from $2.0 million to $6.0 million each upon the first dosing of the first patient in a Phase 3 clinical trial, upon submission of an NDA, and upon commercialization for the first and second indications. If all milestones are achieved, total milestone payments to Dendreon can reach as much as $23.5 million.

Our efforts to manage simultaneously a number of collaboration arrangements may not be successful, and the failure to manage effectively such collaborations would significantly harm our business, financial condition and results of operations.

Due to these factors and other possible disagreements with Amgen, Archemix, Dendreon and Kirin, we may be delayed or prevented from developing or commercializing alfimeprase, ARC183 and rNAPc2 or our pre-clinical product candidates or we may become involved in litigation or arbitration, which would be time-consuming or expensive and could have a material adverse effect on our stock price.

In addition to our existing collaborations, we will focus on effecting new collaborative arrangements where we would share costs of identifying, developing and marketing drug candidates. We cannot assure you that we will be able to negotiate new collaboration arrangements of this type on acceptable terms, or at all.

We are currently dependent on third parties for a variety of functions and may enter into future collaborations for the manufacture and sale of our products. Our arrangements with these third parties may not provide us with the benefits we expect.

We currently rely upon third parties to perform administrative functions and functions related to the research, development, preclinical testing and clinical trials of our drug candidates. In addition, because we do not have the resources, facilities or experience to manufacture our drug candidates on our own, we currently rely, and will continue to rely, on third parties to manufacture our drug candidates for clinical trials, and, if our products are approved, in quantities for commercial sales. We currently rely on a number of sole-source service providers and suppliers and do not have long-term supply agreements with our third-party manufacturers.

        We do not currently have significant manufacturing facilities for clinical or commercial production of our drug candidates and depend on contract research and manufacturing organizations. We may not be able to finalize contractual arrangements, transfer technology or maintain relationships with such organizations in order to file an IND with the FDA, and proceed with clinical trials for any of our drug candidates. We currently rely on Amgen to manufacture our clinical drug product, alfimeprase. We are in the process of transitioning manufacture of alfimeprase from Amgen to an alternate manufacturer. If our efforts are unsuccessful, we may not have adequate supplies of alfimeprase to complete our clinical trials or to commercialize alfimeprase on our anticipated schedule.

We are dependent on third-party contract research organizations to conduct certain research, including good laboratory practices toxicology studies, in order to gather the data necessary to file INDs with the FDA for any of our drug candidates. Our drug candidates have never been manufactured on a commercial scale. Third-party manufacturers may not be able to manufacture these drug candidates at a cost or in quantities necessary to make them commercially viable. In addition, if and when any of our other drug candidates enter the clinical trial phase, we will initially depend on third-party contract manufacturers to produce the volume of current good manufacturing practices materials needed to complete such trials. We will need to enter into contractual relationships with these or other organizations in order to (1) complete the Good Laboratory Practices, or GLP, toxicology and other studies necessary to file an IND with the FDA, and (2) produce a sufficient volume of current cGMP grade material in order to conduct clinical trials of ARC183 and our other drug candidates. We cannot be certain that we will be able to do so on a timely basis or that we will be able to obtain sufficient quantities of material on commercially reasonable terms. In addition, the failure of any of these relationships with third-party contract organizations may delay our filing for an IND or impede our progress through the clinical trial phase. Any significant delay or interruption would have a material adverse effect on our ability to file an IND with the FDA and/or proceed with the clinical trial phase for any of our drug candidates.

Moreover, contract manufacturers that we may use must continually adhere to current cGMP regulations enforced by the FDA through a facilities inspection program. If one of our contract manufacturers fails to maintain compliance, the production of our product candidates could be interrupted, resulting in delays, additional costs and potentially lost revenues. In addition, if the facilities of such manufacturers do not pass a pre-approval plant inspection, the FDA will not grant premarket approval of our products.

Our reliance on these relationships poses a number of risks, including:

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Given these risks, our current and future collaborative efforts with third parties may not be successful. If these efforts fail, we would be required to devote additional internal resources to the activities currently performed, or to be performed, by third parties, to seek alternative third-party collaborators, or to delay our product development or commercialization.

We may not achieve our projected development goals in the time frames we announce and expect.

We set goals for and make public statements regarding the timing of certain accomplishments, such as the commencement and completion of clinical trials, anticipated regulatory approval dates and time of product launch, which we sometimes refer to as milestones. The actual timing of these events can vary dramatically due to a number of factors such as delays or failures in our clinical trials, the uncertainties inherent in the regulatory approval process and delays in achieving manufacturing or marketing arrangements sufficient to commercialize our products. There can be no assurance that our clinical trials will be completed, that we will make regulatory submissions or receive regulatory approvals as planned or that we will be able to adhere to our current schedule for the launch of any of our products. If we fail to achieve one or more of these milestones as planned, our business will be materially adversely affected and the price of our shares could decline.

The success of our potential products in preclinical studies does not guarantee that these results will be replicated in humans.

Although our clinical development-stage drug candidates have shown results in preclinical studies, these results may not be replicated in our clinical trials with humans. Consequently, there is no assurance that the results in our preclinical studies are predictive of the results that we will see in our clinical trials with humans or that they are predictive of whether the resulting products will be safe and effective in humans.

We are dependent on key personnel and we must attract and retain qualified employees and collaborators.

The success of our business is highly dependent on the principal members of our scientific and management staff, including our chairman and senior management team. The loss of the services of any such individual might seriously harm our product development and commercialization efforts. In addition, we will require additional skilled personnel in areas such as clinical development. Retaining and training personnel with the requisite skills is challenging, and, if general economic conditions improve, is likely to become extremely competitive, particularly in Northern California where we are located.

Our success will depend on our ability to attract and retain qualified employees to help develop our potential products and execute our research and development strategy. We have programs in place to retain personnel, including programs to create a positive work environment and competitive compensation packages. Because competition for employees in our field is intense, however, we may be unable to retain our existing personnel or attract additional qualified employees. Our success also depends on the continued availability of outside scientific collaborators, including collaborators at research institutions, to perform research and develop processes to advance and augment our internal research efforts. Competition for collaborators is intense. If we do not attract and retain qualified personnel and scientific collaborators, or if we experience turnover or difficulties recruiting new employees, our research and development programs could be delayed and we could experience difficulties in generating sufficient revenue to maintain our business.

Because we have not yet commercialized any of our drug candidates, our ability to develop and subsequently commercialize products is unproven.

        We have not yet commercialized any of our in-licensed therapeutic product candidates. Moreover, we have not developed any therapeutic products using proteins produced by the genes we have discovered in our internal research programs. Before we make any products available to the public from our internal research and development programs, we or our collaboration partners will need to conduct further research and development and complete laboratory testing and animal and human studies. We or our collaboration partners will need to obtain regulatory approval before releasing any drug products. We have spent, and expect to continue to spend, significant amounts of time and money in our internal research programs in determining the function of genes and the proteins they produce, using our own capabilities and those of our collaboration partners. Such a determination process constitutes the first step in developing commercial products from our internal research programs. We also have spent and will continue to spend significant amounts of time and money in developing processes for manufacturing of our recombinant proteins under preclinical development, yet we may not be able to produce sufficient proteins for preclinical studies. A commercially viable product may never be developed from our gene discoveries.

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Our development of products is subject to several risks, including but not limited to:

Our internally developed drug development programs are currently in the research stage or in preclinical development. None of our potential therapeutic protein candidates from our own portfolio has advanced to Phase 1 clinical trials. Our programs may not move beyond their current stages of development. Even if our internal research does advance, we will need to engage in certain additional preclinical development efforts to determine whether a product is sufficiently safe and effective to enter clinical trials. We have little experience with these activities and may not be successful in developing or commercializing products.

Under our Kirin collaboration arrangement, Kirin has primary responsibility for clinical development in its territory and we have primary responsibility in our territory. Under our collaboration with Archemix, Archemix leads development until Phase 2 clinical trials are reached, and thereafter, a joint steering committee will designate one party to lead development until commercialization. With respect to these arrangements, we run the risk that Kirin or Archemix may not pursue clinical development in a timely or effective manner.

Any regulatory approvals that we or our collaboration partners receive for our product candidates may be subject to limitations on the intended uses for which the product candidates may be marketed or contain requirements for potentially costly post-marketing follow-up studies. In addition, if the FDA approved of our or our collaboration partners’ product candidates, the labeling, packaging, adverse event reporting, storage, advertising, promotion and record-keeping for the products will be subject to extensive regulatory requirements.

In addition, we may not be able to produce any products in commercial quantities at a reasonable cost or may not be able to successfully market such products. If we do not develop a commercially viable product, then we will suffer significant harm to our business, financial condition and operating results.

Our relatively short operating history may affect our ability to execute our business strategy.

We have a short operating history. We commenced operations in the fourth quarter of 1994 with an initial business focused on gene discovery using our signature-by-hybridization platform and applications of our sequencing-by-hybridization technology, including the HyChip system. In 1998, we began to transition our business strategy from gene discovery to research and development of potential therapeutic protein candidates. As a company with a relatively short operating history, we face risks and uncertainties frequently encountered by companies in new and rapidly evolving markets, including:

If we fail to address these risks and uncertainties successfully, our business, results of operations, financial condition and prospects will be materially adversely affected.

We lack marketing and commercialization experience for biopharmaceutical products.

We have no sales, marketing or distribution capability. For the foreseeable future, we intend to rely primarily on collaboration partners or licensees, if any, to market any products we may develop. These collaboration partners or other third parties may not have effective sales forces and distribution systems. If we are unable to maintain or establish such relationships, we will be required to market our products directly and we will have to develop our own marketing and sales force with the appropriate technical expertise and with supporting distribution capabilities. We may not be able to maintain or establish such relationships with third parties or develop in-house sales and distribution capabilities. To the extent that we may depend on our collaboration partners or other third parties for marketing and distribution, any revenues we receive will depend upon the efforts of our collaboration partners or other third parties. Such efforts may not be successful, and we will not be able to control the amount and timing of resources that our collaboration partners or other third parties devote to our products.

Our products may not be accepted in the marketplace, and we may not be able to generate significant revenue, if any.

        Even if they are approved for marketing, our products, if any, may never achieve market acceptance among physicians, patients and the medical community. Our products, if successfully developed, will compete with a number of traditional drugs and therapies manufactured and marketed by major pharmaceutical and other biotechnology companies. Our products will also compete with new products currently under development by such companies and others. The degree of market acceptance of any products developed by us, alone, or in conjunction with our collaboration partners, will depend on a number of factors, including:

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Physicians, patients or the medical community in general may not accept and utilize any of the products that we alone, or in conjunction with our collaboration partners, develop. In practice, competitors may be more effective in marketing their drugs. The lack of such market acceptance would significantly harm our business, financial condition and results of operations.

We face intense competition.

The biopharmaceutical industry is intensely competitive and is accentuated by the rapid pace of technological development. We expect to face increased competition in the future as new companies enter our markets. Research and discoveries by others may result in breakthroughs that render our potential products obsolete even before they begin to generate any revenue. Our competitors include major pharmaceutical and biotechnology firms, many of which have substantially greater research and product development capabilities and financial, scientific, marketing and human resources than we have. Our lead product candidate alfimeprase, if approved, will face competition in the catheter occlusion indication from alteplase, an approved Genentech, Inc. product, and will potentially face competition in the peripheral arterial occlusion, or PAO, indication from product candidates being developed and/or marketed by Abbot Laboratories, Centocor, Inc. and Genentech.

Our competitors may obtain patents and regulatory approvals for their competing products more rapidly than we or our collaboration partners, or develop products that are more effective than those developed by us or our collaboration partners. Any potential products based on genes we identify ultimately will face competition from other companies developing gene-based products as well as from companies developing other forms of treatment for diseases which may be caused by, or related to, the genes we identify. Similarly, our products will face competition from other companies developing similar products as well as from companies developing other forms of treatment for the same conditions.

Many of the companies developing competing products have significantly greater financial resources than we have. Many such companies also have greater expertise than we or our collaboration partners have in discovery, research and development, manufacturing, preclinical and clinical testing, obtaining regulatory approvals and marketing. Other smaller companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These companies and institutions compete with us in recruiting and retaining qualified scientific and management personnel as well as in acquiring technologies complementary to our programs. We will face competition with respect to:

There can be no assurance that research and development by others will not render the products that we may develop obsolete or uneconomical, or result in treatments or cures superior to any therapy developed by us or that any therapy we develop will be preferred to any existing or newly developed alternative products.

We face uncertainty with respect to coverage, pricing, third-party reimbursements and health care reform.

Our ability to collect significant royalties from our products may depend on our ability, and the ability of our collaboration partners or customers, to obtain adequate levels of coverage for our products and reimbursement from third-party payers such as:

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Third-party payers may deny coverage or offer inadequate levels of reimbursement if they determine that a prescribed product or device has not received appropriate clearances from the FDA or other government regulators, is not used in accordance with cost-effective treatment methods as determined by the third-party payer, or is experimental, unnecessary or inappropriate. If third-party payers deny coverage or offer inadequate levels of reimbursement, we may not be able to market our products effectively. We also face the risk that we will have to offer our products at prices lower than anticipated as a result of the current trend in the United States towards managed health care through health maintenance organizations. Currently, third-party payers are increasingly challenging the prices charged for medical products and services. Prices could be driven down by health maintenance organizations that control or significantly influence purchases of health care services and products. Legislative proposals to reform health care or reduce government insurance programs could also adversely affect prices of our products. The cost containment measures that health care providers are instituting and the results of potential health care reforms may prevent us from maintaining prices for our products that are sufficient for us to realize profits and may otherwise significantly harm our business, financial condition and operating results.

We and/or Callida may merge with or acquire other companies and our failure to receive the anticipated benefits in these transactions could harm our business.

In January 2003, we merged with Variagenics, and we and/or Callida may merge with or acquire other companies in the future. The success of any merger or acquisition depends, in part, on our ability to realize the anticipated synergies, cost savings and growth opportunities from integrating the business of the merged or acquired company with our business. The integration of two independent companies is a complex, costly and time-consuming process. The difficulties of combining the operations of the companies and/or our subsidiary include, among others:

Moreover, we have assumed the costs of defending against litigation claims asserted against Variagenics, and anytime we or our subsidiary merge with or acquire another company, we will be exposed to similar costs. In addition, we may be exposed to a number of other risks in connection with future transactions, including:

We cannot assure you that we will receive all of the anticipated benefits of any mergers or acquisitions, or that any of the risks described above will not occur. Our failure to receive anticipated benefits of, and our exposure to inherent risks in, any such merger or acquisition transaction could significantly harm our business, financial condition and operating results.

We are subject to the risk of natural disasters and power blackouts.

Our facilities are located in Northern California. If a fire or other natural disaster (such as an earthquake) disrupts our research or development efforts, our business, financial condition and operating results could be materially adversely affected. Some of our landlords maintain earthquake coverage for our facilities. Although we maintain personal property and business interruption coverage, we do not maintain earthquake coverage for personal property or resulting business interruption.

RISKS RELATED TO OUR CAPITAL STRUCTURE AND FINANCIAL RESULTS

We have not been profitable, anticipate continuing losses and may never become profitable.

For the year ended December 31, 2001, we had a net loss of $36.5 million. For the year ended December 31, 2002, we had a net loss of $45.0 million. For the year ended December 31, 2003, we had a net loss of $50.2 million. As of September 30, 2004, we had an accumulated deficit of $243.1 million.

All of our product candidates are in various stages of product development, and some are still in research or in early development. None of them are approved for sale. The process of developing our drug products will require significant additional research and development, preclinical testing, clinical trials and regulatory approvals.

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These activities, together with general administrative and other expenses, are expected to result in operating losses for the foreseeable future. To date, we have not generated any revenues from product sales. We do not expect to achieve significant product sales or royalty revenue for several years, and we may never do so. We expect to incur additional operating losses in the future, and these losses may increase significantly as we continue preclinical research and clinical trials, apply for regulatory approvals, develop our drug candidates, expand our operations and develop systems that support commercialization of our potential products. These losses, among other things, have caused and may cause our stockholders’ equity and working capital to decrease. We may not be successful in developing our drug candidates, obtaining regulatory approvals and commercializing our products, and our operations may not be profitable even if any of our drug candidates are commercialized. We may never generate profits and, as a result, the trading price of our common stock could decline.

Moreover, utilization of our net operating loss carryforwards and credits may be subject to an annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986 and similar state law provisions. It is possible that certain transactions that we have entered into, including our merger with Variagenics that occurred in January 2003, when considered in connection with other transactions, may result in a “change in ownership” for purposes of these provisions.

We will need to raise additional capital, and such capital may be unavailable to us when we need it or not available on acceptable terms.

Even though we raised net proceeds of $69.5 million from our public offering completed on March 8, 2004, we will need to continue to raise significant additional capital. Financing may be unavailable when we need it or may not be available on acceptable terms. The unavailability of financing may require us to delay, scale back or eliminate expenditures for our research, development and marketing activities necessary to commercialize our potential biopharmaceutical products. We may also be required to raise capital by granting rights to third parties to develop and market drug candidates that we would prefer to develop and market on our own, potentially reducing the ultimate value that we could realize from these drug candidates.

If we are unable to obtain additional financing when we need it, the capital markets may perceive that we are not able to raise the amount of financing we desire, or on the terms that we desire. This perception, if it occurs, may negatively affect the trading price of our common stock. If sufficient capital is not available, we may be forced to delay, reduce the scope of, eliminate or divest one or more of our research or development programs. Any such action could significantly harm our business, financial condition and results of operations.

Our future capital requirements and the adequacy of our currently available funds will depend on many factors, including, among others, the following:

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We may face fluctuations in operating results.

Our operating results may rise or fall significantly as a result of many factors, including:

Excluding our three clinical stage drug candidates, our potential products currently are in research or preclinical development, and revenues from the sales of any products resulting from these efforts may not occur for several years, if at all. A high percentage of our expenses are fixed costs such as lease obligations. As a result, we may experience fluctuations in our operating results from quarter to quarter and continue to generate losses. Quarterly comparisons of our financial results may not necessarily be meaningful, and investors should not rely upon such results as an indication of our future performance. In addition, investors may react adversely if our reported operating results are less favorable than in a prior period or are less favorable than those anticipated by investors or the financial community, which may result in a drop of our stock price.

Our subsidiary Callida may not be able to raise third-party financing.

In October 2001, we formed Callida to develop and commercialize our sequencing by hybridization technology. We recognized 90% of Callida’s operating losses in our consolidated results of operations up to the point where Affymetrix’s initial minority interest investment was depleted in the first quarter of 2002. Beyond that point, we absorb 100% of the net losses until Callida generates net income. There is no guarantee, however, that Callida will meet its technical milestone and other requirements to obtain additional funding through Affymetrix and us. There is also no assurance that Callida will be able to obtain any third-party financing or that any such financing that Callida obtains will be on favorable terms or that the funding from outside sources will be sufficient to fund Callida’s operations. We cannot assure the success of Callida, and if Callida is unable to obtain sufficient funding from outside sources, we may reduce projects and/or bear the costs of financing Callida ourselves, which will divert our resources from our biopharmaceutical research and development projects. In March 2003, Callida reduced its number of employees from 25 to 6 in order to preserve cash. As of September 30, 2004, Callida and its subsidiary, N-Mer, Inc., had approximately $88,000 in cash and investments available for future operations.

Future sales of our common stock may depress the market price of our common stock.

Sales in the public market of substantial amounts of our common stock could depress prevailing market prices of our common stock. As of September 30, 2004, we had 32,199,571 shares of our common stock outstanding. All of these shares are freely transferable without restriction or further registration under the Securities Act of 1933, as amended, or the Securities Act, except for shares held by our affiliates and unregistered shares held by non-affiliates. Although we do not believe that our affiliates have any present intentions to dispose of any shares of common stock owned by them, there can be no assurance that such intentions will not change in the future. The sale of these additional shares could depress the market price of our common stock.

As of September 30, 2004, warrants to purchase 1,516,792 shares of our common stock were outstanding. Options to exercise 4,356,957 shares of our common stock were outstanding under our 2004 Equity Incentive Plan, 2002 Equity Incentive Plan, 1995 Stock Option Plan, Non-Employee Director Stock Option Plan, Scientific Advisory Board/ Consultants Stock Option Plan, the Variagenics, Inc. Amended 1997 Employee Director and Consultant Stock Option Plan, and stock option agreements entered into outside of any of our stock option plans. In addition, we have 4,188,424 shares remaining for future option grants under our 2004 Equity Incentive Plan. Under our Employee Stock Purchase Plan, we have approximately 64,997 shares of our common stock reserved for future issuance as of September 30, 2004. The introduction into the market of additional shares of common stock following the exercise of these currently outstanding warrants and options to purchase our common stock may negatively affect the market price of our common stock.

        As of September 30, 2004, 576,376 shares of our common stock were issuable upon repayment of a note in the principal amount of $4,000,000 held by Affymetrix. Affymetrix has the ability to declare all outstanding principal and interest under the note immediately due and payable in the event that our market capitalization is under $50 million and Affymetrix reasonably determines that the loan evidenced by the note is impaired, and we have an obligation to prepay amounts owing under the note to the extent that the amounts outstanding exceed 10% of our market capitalization. Moreover, we have registered for resale a portion of these shares on a registration statement that has been declared effective by the SEC. If we decide to repay this note with our common stock, whether pursuant to acceleration of the note or otherwise, the resale of shares of our common stock received by Affymetrix may also result in significant downward pressure on the price of our common stock.

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In addition, we will need to raise additional capital to finance the research and clinical development of our drug products. If future securities offerings are successful, they could dilute our current shareholders’ equity interests and reduce the market price of our common stock.

We do not intend to pay cash dividends on our common stock in the foreseeable future.

We do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will depend upon our financial condition, results of operations, capital requirements and other factors and will be at the discretion of the Board of Directors. Furthermore, we may incur additional indebtedness that may severely restrict or prohibit the payment of dividends.

If registration rights that we have previously granted are exercised, then our stock price may be negatively affected.

We have granted registration rights in connection with the issuance of our securities to a number of our stockholders and warrant holders. In the aggregate, as of September 30, 2004, these registration rights covered approximately 1,516,792 shares of our common stock which were then outstanding or which may become outstanding upon the exercise of warrants that were then outstanding. If these registration rights, or similar registration rights that may apply to securities we may issue in the future, are exercised by the holders, it could result in additional sales of our common stock in the market, which may have an adverse effect on our stock price.

We have implemented anti-takeover provisions that could discourage, prevent or delay a takeover, even if the acquisition would be beneficial to our stockholders.

The existence of our stockholder rights plan and provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. These provisions:

Specifically, our certificate of incorporation provides that all stockholder action must be effected at a duly called meeting and not by a consent in writing. The by-laws provide, however, that our stockholders may call a special meeting of stockholders only upon a request of stockholders owning at least 50% of our common stock. These provisions of our certificate of incorporation and our by-laws could discourage potential acquisition proposals and could delay or prevent a change in control. We designed these provisions to reduce our vulnerability to unsolicited acquisition proposals and to discourage certain tactics that may be used in proxy fights. These provisions, however, could also have the effect of discouraging others from making tender offers for our shares. As a consequence, they also may inhibit fluctuations in the market price of our shares that could result from actual or rumored takeover attempts. Such provisions also may have the effect of preventing changes in our management.

We are permitted to issue shares of our preferred stock without stockholder approval upon such terms as our board of directors determines. Therefore, the rights of the holders of our common stock are subject to, and may be adversely affected by, the rights of the holders of our preferred stock that may be issued in the future. In addition, the issuance of preferred stock could have a dilutive effect on the holdings of our current stockholders.

On June 5, 1998, our board of directors adopted a rights plan and declared a dividend with respect to each share of our common stock then outstanding. This dividend took the form of a right, which entitles the holders to purchase one one-thousandth of a share of our Series A junior participating preferred stock at a purchase price that is subject to adjustment from time to time. These rights have also been issued in connection with each share of our common stock issued after June 15, 1998. The rights are exercisable only if a person or entity or affiliated group of persons or entities acquires, or has announced its intention to acquire, 15% (27.5% in the case of certain approved stockholders) or more of our outstanding common stock. The adoption of the rights plan makes it more difficult for a third party to acquire control of us without the approval of our board of directors. This rights agreement was amended on March 19, 2004, to ensure that it would remain in full force and effect after our reincorporation under Delaware law.

We are subject to the Delaware anti-takeover laws regulating corporate takeovers. These anti-takeover laws prevent a Delaware corporation from engaging in a merger or sale of more than 10 percent of its assets with any stockholder, including all affiliates and associates of the stockholder, who owns 15 percent or more of the corporation’s outstanding voting stock, for three years following the date that the stockholder acquired 15 percent or more of the corporation’s stock unless:

The provisions of our governing documents, our existing agreements and current Delaware law may, collectively:

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RISKS RELATED TO INTELLECTUAL PROPERTY AND OTHER LEGAL MATTERS

The commercial success of our products will be dependent upon our ability to protect the intellectual property rights associated with our products and drug candidates.

Our competitive success will depend in part on our ability to obtain and maintain patent protection for our inventions, technologies and discoveries, including intellectual property that we license. The patent positions of biotechnology companies involve complex legal and factual questions, and we cannot assure you that our patents and licenses will successfully preclude others from using our technology. We could incur substantial costs in seeking enforcement of our proprietary rights against infringement. In addition, to obtain a patent on a novel gene or the protein it encodes, we need to identify a utility for the novel gene or the encoded protein we seek to protect under patent law. Identifying a utility may require significant research and development with respect to which we may incur a substantial expense and invest a significant amount of time.

We currently have, or have in-licensed, issued patents and pending patent applications that cover portions of our in-licensed clinical products. ARC183 is covered both by a U.S. patent specifically claiming ARC183 and by U.S. patents covering aptamers generically. However, there are no equivalent international applications pending specifically claiming ARC183. International patent applications generically covering aptamers are pending but we cannot assure you that such patents will issue. We also currently have patents that cover some of our technological discoveries and patent applications that we expect to protect some of our gene, protein and technological discoveries. We have approximately 32 issued patents relating to our gene and protein discoveries. We also currently have or have rights to 44 issued patents which cover or describe single nucleotide polymorpohisms and their application to pharmacogenetic studies, genotyping and haplotyping methods, and allele specific inhibitors. In addition, we have rights to 22 issued U.S. patents relating to the in-licensed clinical products. We will continue to apply for patents for our discoveries. We cannot assure you that any of our applications will issue as patents, or that any patent issued or licensed to us will not be challenged, invalidated, circumvented or held unenforceable by way of an interference proceeding or litigation.

The timing of the grant of a patent cannot be predicted. Patent applications describing and seeking patent protection of methods, compositions, or processes relating to proprietary inventions involving human therapeutics could require us to generate data, which may involve substantial costs. Our pending patent applications may lack priority over others’ applications or may not result in the issuance of patents. Even if issued, our patents may not be sufficiently broad to provide protection against competitors with similar technologies and may be challenged, invalidated or circumvented.

In addition to patents, we rely on a combination of trade secrets, copyright and trademark laws, nondisclosure agreements, licenses and other contractual provisions and technical measures to maintain and develop our competitive position with respect to intellectual property. Nevertheless, these measures may not be adequate to safeguard the technology underlying our products. For example, employees, consultants and others who participate in the development of our products may breach their agreements with us regarding our intellectual property and we may not have adequate remedies for the breach. Our trade secrets could become known through other unforeseen means.

We also may not be able to effectively protect our intellectual property rights in some foreign countries, as many countries do not offer the same level of legal protection for intellectual property as the United States. Furthermore, certain of the patent applications describing our proprietary methods are filed only in the United States. Even where we have filed our patent applications internationally, for some cases and in certain countries, we have chosen not to maintain foreign patent protection by opting not to enter national phase or opting not to pay maintenance annuities.

Notwithstanding our efforts to protect our intellectual property, our competitors may independently develop similar or alternative technologies or products that are equal or superior to our technology. Our competitors may also develop similar products without infringing on any of our intellectual property rights or design around our proprietary technologies.

If our products infringe on the intellectual property rights of others, we could face costly litigation, which could cause us to pay substantial damages and limit our ability to sell some or all of our products.

Extensive litigation regarding patents and other intellectual property rights has been common in the genomics and biopharmaceutical industries. Litigation may be necessary to assert infringement claims, enforce patent rights, protect trade secrets or know-how and determine the enforceability, scope and validity of certain proprietary rights. The defense and prosecution of intellectual property lawsuits, United States Patent and Trademark Office interference proceedings, and related legal and administrative proceedings in the United States and internationally involve complex legal and factual questions. As a result, such proceedings are costly and time-consuming to pursue and their outcome is uncertain.

        Regardless of merit or outcome, our involvement in any litigation, interference or other administrative proceedings could cause us to incur substantial expense and could significantly divert the efforts of our technical and management personnel. An adverse determination may subject us to the loss of our proprietary position or to significant liabilities, or require us to seek licenses that may include substantial cost and ongoing royalties. Licenses may not be available from third parties, or may not be obtainable on satisfactory terms. An adverse determination or a failure to obtain necessary licenses may restrict or prevent us from manufacturing and selling our products, if any. These outcomes could materially harm our business, financial condition and results of operations.

Our market success depends in part on us neither infringing valid, enforceable patents or proprietary rights of third parties, nor breaching any licenses that may relate to our technologies and products. We are aware of third-party patents that may relate to our technology. We may be required to obtain licenses to patents or other proprietary rights of others in order to conduct research, development, or commercialization of some or all of our programs. We plan to seek licenses, as we deem appropriate, but it is possible that we may unintentionally infringe upon these patents or proprietary rights of third parties. If we do not obtain these licenses, we may encounter delays in product market introductions, incur substantial costs while we attempt to design around existing patents or not be able to develop, manufacture or sell products. In response, third parties may assert infringement or other intellectual property claims against us. We may consequently be subjected to substantial damages for past infringement or be required to modify our products if it is ultimately determined that our products infringe a third party’s proprietary rights. Further, we may be prohibited from selling our products before we obtain a license, which, if available at all, may require us to pay substantial royalties, which could adversely impact our product costs and have an impact on our business. Further, if we do obtain these licenses, the agreed terms may necessitate reevaluation of the potential commercialization of any one of our programs. Failing to obtain a license could result in litigation. Even if these claims are without merit, defending a lawsuit takes significant time, may be expensive and may divert management attention from other business concerns. Any public announcements related to litigation or interference proceedings initiated or threatened against us could cause our stock price to decline.

We face product liability exposure and potential unavailability of insurance.

We risk financial exposure to product liability claims in the event that the use of products developed by us or our collaboration partners, if any, result in personal injury.

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We may experience losses due to product liability claims in the future. We have obtained limited product liability insurance coverage. Such coverage, however, may not be adequate or may not continue to be available to us in sufficient amounts or at an acceptable cost, or at all. We may not be able to obtain commercially reasonable product liability insurance for any product approved for marketing. A product liability claim or other claim, product recalls, as well as any claims for uninsured liabilities or in excess of insured liabilities, may significantly harm our business, financial condition and results of operations.

We use hazardous materials, chemicals and patient samples in our business and any disputes relating to improper handling, storage or disposal of these materials could be time consuming and costly.

Our research and development and production activities involve the controlled use of hazardous or radioactive materials, chemicals, including oxidizing and reducing reagents, patient tissue and blood samples. We, our collaborators and service providers are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and certain waste products. We could be liable for accidental contamination or discharge or any resultant injury from hazardous materials, and conveyance, processing, and storage of and data on patient samples. If we, our collaborators or service providers fail to comply with applicable laws or regulations, we could be required to pay penalties or be held liable for any damages that result and this liability could exceed our financial resources. Further, future changes to environmental health and safety laws could cause us to incur additional expense or restrict our operations.

In addition, our collaborators and service providers may be working with these types of hazardous materials, including viruses and hazardous chemicals, in connection with our collaborations. In the event of a lawsuit or investigation, we could be held responsible for any injury caused to persons or property by exposure to, or release of, patient samples that may contain viruses and hazardous materials. The cost of this liability could exceed our resources.

Variagenics has been named as a defendant in a class action suit and defending this litigation could hurt our business.

Variagenics has been named as a defendant in a securities class action lawsuit alleging the failure to disclose additional and excessive commissions purportedly solicited by and paid to underwriters who are also named defendants in the lawsuit. Plaintiffs in the suit allege that underwriters took these commissions and in exchange allocated shares of Variagenics’ stock to their preferred customers through alleged agreements with these preferred customers that tied the allocation of initial public offering shares to agreements by the customers to make additional aftermarket purchases at pre-determined prices. As a result of our merger with Variagenics, we are obligated to continue to defend against this litigation. Currently we are in the process of approving a settlement by and between the issuers that are defendants in the lawsuit, the insurers of those issuers, and the plaintiffs. We believe that any loss or settlement amount will not be material to our financial position or results of operation, and that any settlement payment and attorneys’ fees accrued with respect to the suit will be paid by our insurance provider. However, we cannot assure you that this will be the case until a final settlement is executed. Failure to finalize a settlement could require us to pay substantial damages.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk, including changes in interest rates and short-term investment prices. We do not use derivative financial instruments in our investment portfolio. We place our investments with high quality issuers and, by policy, limit the amount of credit exposure to any one issuer. We are averse to principal loss and ensure the safety and preservation of our invested funds by limiting default, market and reinvestment risk.

We also have exposure to changes in interest rates in our line of credit with our Chairman of the Board, which bears interest at the prime rate plus one percent. Our interest rate exposure is mitigated by our ability to repay amounts outstanding under the line of credit with our common stock. In addition, our term loan borrowings under the new loan facility shall bear interest at a fixed rate per annum equal to the 36-month Treasury Rate in effect on the funding date plus three and one-quarter percent (3.25%), and, in any event, shall not be less than 6.43% per annum.

Changes in interest rates do not affect interest income on our restricted cash as it is maintained in commercial paper with fixed rates and maturities of less than 90 days. Changes in interest rates do not affect interest expense on our lease obligations as they bear fixed rates of interest. Changes in interest rates do not affect our note payable as it bears a fixed rate of interest.

There were no significant changes in our market risk exposures through the third quarter of 2004 since our Form 10-K filing on March 12, 2004.

ITEM 4. CONTROLS AND PROCEDURES

        We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

We have initiated a company-wide review of our internal controls over financial reporting as part of the process of preparing for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and as a complement to our existing overall program of internal controls over financial reporting. As a result of this on-going review, we have made numerous improvements to the design and effectiveness of our internal controls over financial reporting through the quarterly period ended September 30, 2004. We anticipate that improvements will continue to be made. There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On or about December 6, 2001, Variagenics was sued in a complaint filed in the United States District Court for the Southern District of New York naming it and certain of its officers and underwriters as defendants. The complaint purportedly is filed on behalf of persons purchasing the Company’s stock between July 21, 2000 and December 6, 2000, and alleges violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, as amended and Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder.

The complaint alleges that, in connection with Variagenics, July 21, 2000 initial public offering, the defendants failed to disclose additional and excessive commissions purportedly solicited by and paid to the underwriter defendants. Plaintiffs in the suit allege that underwriters took these commissions and in exchange allocated shares of Variagenics’ stock to their preferred customers through alleged agreements with these preferred customers that tied the allocation of initial public offering shares to agreements by the customers to make additional aftermarket purchases at pre-determined prices. Plaintiffs claim that the failure to disclose these alleged arrangements made Variagenics’ registration statement on Form S-1 filed with the SEC in July 2000 and the prospectus included therein, materially false and misleading. Plaintiffs seek unspecified damages. On or about April 19, 2002, an amended complaint was filed which makes essentially the same allegations. On or about July 15, 2002, Variagenics and the individuals filed a motion to dismiss. We are involved in this litigation as a result of our merger with Variagenics in January 2003.

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On July 16, 2003, the Nuvelo Board approved a settlement proposal initiated by the plaintiffs. The final terms of the settlement are still being negotiated.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On September 9, 2004, Nuvelo issued an aggregate of 240,842 shares of its common stock to Wells Fargo Bank, N.A., pursuant to the cash exercise of four warrants, each dated July 30, 1999. The warrants were exercisable for a total of 240,842 shares of common stock and each warrant had an exercise price of $4.98 per share. The issuances of the shares pursuant to these warrants were exempt from registration under the Securities Act of 1933 in reliance on Section 4(2) promulgated thereunder as a transaction not involving any public offering.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS

(a) Exhibits

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

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EXHIBIT INDEX

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